(Bloomberg) — Federal Reserve Vice Chair Lael Brainard sat down for a question-and-answer session with Bloomberg’s Washington Bureau Chief Peggy Collins on Monday.
Here is the transcript from their discussion and the subsequent questions from other journalists. The text has been lightly edited:
Collins: I think we’ll start off this morning with a question about the CPI report that came out last week. It showed that inflation is slowing a bit and so I’m wondering: how strong now do you think the case is for downshifting at the December meeting to something more like a 50 basis-point cut?
Brainard: I think the most recent CPI inflation print suggests that maybe the core PCE measure that we really focus on might be also showing a little bit of a reduction. When we get those October numbers later his month maybe from about 0.5 monthly — month over month — in August and September may be down to 0.3. And that would be welcome.
I think the inflation data was reassuring preliminarily, just in terms of showing a slowing in categories that I had been anticipating.
So if you kind of pull it apart you know, obviously, food and energy — that reflects the war, Mr. Putin, and some weather issues. So we really are focused on those core numbers.
Within core, we’re finally starting to see goods inflation starting to turn over and that is consistent with the data that we’ve seen on lower shipping times; more availability of automotive semiconductors, for instance, wholesale prices on used cars turning over; and just generally starting to see those goods prices turning down.
And that’s a really important trend that we’ll need to continue over the next year if we’re going to see overall disinflation.
Within services though, core services, housing remains quite strong. It’s going to take probably well until next year until we start to see those new lease numbers starting to filter through to the average housing services.
And then on non-housing core services, that’s where you’re seeing people moving their demand, which had been very strongly in goods, over to leisure and hospitality — restaurants, hotels.
Their wages are going to be more important over time, and that’s where labor demand-supply imbalances have been the greatest. And there too, we are starting to see the wage series — whether you look at the ECI or average hourly earnings on a quarter by quarter — they are stepping down, but that’s going to take time.
So I’m happy to turn next to what that means for policy.
Downshift Timing
Collins: Yes, exactly. Do you think the downshift is coming?
Brainard: I think it will probably be appropriate soon to move to a slower pace of increases. But I think what’s really important to emphasize — we’ve done a lot, but we have additional work to do both on raising rates and sustaining restraint to bring inflation down to 2% over time.
We have raised rates very rapidly by nearly four percentage points over about nine months and we’ve been reducing the balance sheet, and you can see that in financial conditions. You can see it in inflation expectations, which are quite well anchored. You can see it in interest-rate-sensitive sectors.
But as we said last meeting, there are likely to be lags and it’s going to take some time for that cumulative tightening to flow through. And so it makes sense to move to a more deliberate and a more data-dependent pace as we continue to make sure that there’s restraint that will bring inflation down over time.
Peak Rate
Collins: Another thing that Chair Powell brought up in his latest press conference was where we’ll end up — that peak — and he was essentially saying that he thinks we’ll end up at a higher peak than people may have originally thought. Do you agree with that?
Brainard: So these are questions that are very much going to be informed by the flow of data. Even for just the December meeting’s decision, we still will have additional data in hand by the time.
Members of the committee will be submitting their new projections. And of course, those projections are going to reflect that data both on inflation as well as on the labor-market activity more generally. But it is the case that we do have additional work to do on raising rates and that by moving forward at a pace that’s more deliberate we’ll be able to assess more data and be better able to adjust the path of rates to bring inflation down.
Recession Risk
Collins: Bloomberg Economics is forecasting 100% chance of a recession in the next 12 months. What is your forecast for where we end up in terms of unemployment by the end of next year?
Brainard: I think it’s very difficult to give firm projections, because this is a very unusual labor market. The pandemic led to a lot of departures from in-person services in particular. And if you look at hiring data, you can still see pretty healthy hiring in some of those in-person services where some businesses are still trying to catch up to levels of employment that may be appropriate for the kind of the run rate that they’re seeing.
But it is the case that as rates move further into restrictive territory, and financial conditions remain tight, that does exert some restraint on demand to bring demand into better alignment with supply and so you will see some reallocation.
Now vacancies are unusually high relative to unemployment. And that does suggest for the reasons that we were just talking about this sort of catch-up hiring. There’s some chance that we’ll see more of a diminution in those vacancies rather than putting as much emphasis on layoffs. But it’s likely there’ll be a combination of both, and so we’ll just be watching the labor market as well as inflation very carefully as we go forward.
Crypto Meltdown
Collins: You said in July that you didn’t see much interconnectivity yet between crypto and the broader financial market to imply a systemic risk. How has your view changed, given what’s happened in the past week with FTX?
Brainard: I don’t think my view has fundamentally changed. First of all, you know, it is really concerning to see that retail investors are really getting hurt by these losses. And it is also the case that despite a lot of hype — you heard a lot about how decentralized these markets are and how innovative and different — it turns out they’re highly concentrated, highly interconnected, and you’re just seeing a domino effect: Failures from one platform or one firm spilling over elsewhere.
It reinforces this need to make sure that crypto finance — because it is no different than traditional finance in the risks that it exposes investors to — needs to be under the regulatory perimeter. And it’s precisely these issues of interconnectedness, leverage, liquidity that are traditional financial risks, and consumer protection, retail protection — we really need to make sure that that environment has the appropriate regulatory guardrails, whether that means bringing some into compliance with existing rules or in some cases, expanding that regulatory perimeter.
But in order for the innovation that is in some of those platforms to actually make a positive contribution, there need to be strong regulatory guardrails that assure that like risks are subject to like disclosures and like regulatory outcomes.
Strong Dollar
Collins: How much risk is posed by the strength of the dollar and could spillovers boomerang back to hurt the US economically?
Brainard: I think there are clearly complicated geostrategic risks. There are risks associated with very high inflation around most of the world’s economy and the need for rapid tightening to address that. That creates spillovers between different economies. And you’re seeing that in financial-market reaction.
In a highly uncertain environment with high volatility, it leads to the need for rapid adjustments. And that can sometimes strain liquidity in core funding markets, and that can also sometimes reveal pockets of hidden leverage that maybe were not so apparent to other market participants or even in some cases, to regulators.
So we are very focused on potential spillovers. I think we’re highly cognizant that in a world where many large central banks or central banks and large jurisdictions are tightening at the same time that that is greater than the sum of its parts.
In the case of the US, it reinforces the tightening that we’re doing here because not only do we see it in terms of reduced demand for our products abroad, ultimately, but we also see it through spillovers of tighter financial conditions and through the dollar.
But for other countries, spillovers may also create some real risks. For instance, those as you were mentioning, who might be commodity importers or those subject to exchange-rate risk both in their trade balance but also in the mismatch between assets and liabilities. So we’re on the lookout, very vigilant about potential global risks.
Corporate Profits
Collins: You have recently mentioned corporate profit margins and markups. How much room is there for a reduction in margins and could that help bring inflation down?
Brainard: The data is not comprehensive, but certainly in the retail sector, you can look at retail margins, relative to how much wages have been growing in that retail activity. And you can look at that markup, and how it compares with inventory-to-sales ratios.
So normally, as inventory-to-sales ratios increase, you’d actually expect more competitive pressure to start bringing those markups down. That’s particularly true when consumers are price sensitive. That process has led to first of all very high retail markups, in some cases, many times the increase in the average hourly earnings in that sector, and now that inventory/sales ratios are improving and getting back to pre-pandemic levels, in some cases, even above them.
It’s been slow to sort of see that markup coming back down, but it’s a process that you would expect at this point in the cycle. So I’m certainly looking at that closely. And of course, that would contribute to disinflation in those sectors.
Fed’s Credibility
Collins: Turning to Fed credibility, both on its inflation-fighting performance and in connection with revelations about trading activity by some senior officials: How much damage do you think has been done to the Feds credibility over the past few years?
Brainard: I think that first of all, in those cases where our rules were not clear enough, or where there were inconsistencies with stronger rules at the board than at the Reserve Banks, even though we’re all FOMC members, that we’ve taken very rapid action to bring those rules into conformity and we also have put in place sort of ethics processes at the Reserve Banks that will better catch those issues sooner and lead to self-identification and stronger compliance with those roles.
So — critically important we understand that we serve the American public, that we have to build trust with the American public, and that we had some work to do following those breaches. And we’re very committed to continuing to strengthen the trust placed in the Federal Reserve, and I think that’s across both our rules but also our policymaking.
Labor Market
Collins: In August 2020, the Fed came out with a new framework, which included a commitment to seek broad and inclusive employment. How hard will it be to deliver on that commitment given that there’s so much pressure on the Fed to get inflation down?
Brainard: The focus on broad and inclusive employment is really core to our work. And so if you look right now, it’s a recovery in employment, what you’ll see is that unemployment is actually back around the level that was in place prior to the pandemic. And employment outcomes for demographic groups, racial and ethnic groups, are actually quite similar to where they were pre-pandemic. And of course, they had improved for Black workers and Hispanic workers in particular a great deal over the course of this very long recovery.
In terms of, going forward, I’d like to continue to see gains among those groups. Those disparities that we saw right prior to the pandemic are, again, evident today. But again, that was after some really important improvement had taken place.
The other things that we’re seeing is there was a lot of people who left leisure and hospitality as I noted earlier. The sort of in-person services arena continues to be an area where I think it’s harder to attract people back.
And early retirees is a huge new phenomenon. We’re missing a very large number of people from the workforce that would have been projected to be working. So we’re very focused on that.
But our mandate, our framework, our approach, is very much around the keeping inflation expectations anchored at 2%. And I think you’ve seen that we’ve worked hard at that. And that in fact, inflation expectations have been anchored. Very important.
We’ve shown very strong resolve to get inflation down. And I think we’ll continue to take the necessary steps while also being very mindful of the labor market.
Early Retirees
Collins: Do you think those early retirees will come back in any notable way?
Brainard: It does seem to be somewhat correlated among different demographic groups. So you see some of those early retirements being more concentrated among White workers and among college educated workers. I don’t know if that really tells us very much about whether they’re likely to come back or not.
But certainly, as we think about resolving imbalances, one of the important imbalances is labor demand, and labor supply, particularly in some of those in-person, services areas. And so, it would be great to see a return of workers. That of course, would be the best outcome. If we don’t see that, obviously, you need restraint on the demand side to bring it into alignment with that reduced supply.
Pivot Coming?
Collins: When you look ahead to next year, would you be surprised if the Fed actually reverses course and cut rates at some point next year as some people on Wall Street think might happen?
Brainard: I think what we talked about in the last meeting, which is taking into account the cumulative amount of tightening that is in place, and the lags with which tightening and financial conditions flows through to activity and to inflation.
I think by moving at a more deliberate pace, we’ll actually be able to see how that cumulative tightening is playing out and how much additional tightening. You know, as we get into restrictive territory or further into restrictive territory, risks become more two sided.
And in that environment, it’s really valuable to be able to take into account the data as we go, and so that should enable us to move to a restrictive level that is appropriate for bringing inflation down over some period of time. Exactly what that path looks like I think is really hard to say right now.
But I think it will be very much, you know, sort of better at balancing those risks by virtue of being able to take on board more data.
Pandemic’s Impact
Collins: How did the pandemic change you?
Brainard: The pandemic brought a lot of tragedy and heartache to families and workers around the country, really around the world. And we’re still seeing some of that, both in terms of people’s willingness to go back to some of the jobs that were so hard being on the front lines during the pandemic — you think about health care, you know, in person services, generally — those were really taxing and stressful jobs.
But the flip side of that is we also learned that we can do a tremendous number of things in a way that’s enabled by technology remotely, and effectively and productively. We did all of our operations remotely, which is a remarkable thing. If you’d asked me six months beforehand, would that be something that you would feel confident about, I would have said absolutely not. But we were able to do that and so it was, you know, companies all over the world.
So there’s some positive implications for the economy. It may take a while. But for people’s ability to work in ways that they are more productive and more satisfied and also for the economy, I think to be more productive, and hopefully more resilient into the future.
I think between the pandemic and the work, there’s probably some rethinking of cost savings versus resilience. Companies are reconfiguring supply chains to take those things into account. So I’m hopeful that some of these changes will actually lead to a more flexible economy going forward.
Labor Hoarding
Collins: Great. Well, I do want to open it up to questions. Does anyone from the audience have one? Would you mind giving your name and affiliation when you ask a question, just so the vice chair can know?
Chris Rugaber: Sure, hi. Chris Rugaber at Associated Press. You mentioned the potential for catchup hiring in areas like leisure and hospitality. And there’s also been plenty of anecdotes I think, including in the Beige Book about potential labor hoarding. Do those two combine potentially to create more labor demand than you might want to see going forward, therefore perhaps more wage pressure, even if the economy were to slow a bit?
Brainard: So you know, the stories about catchup hiring and labor hoarding — if you look at some of the recent hiring data, it does look actually like the strongest hiring has been in those catchup areas. So it’s really a sectoral story rather than an aggregate demand overall story, you know, and if you — which, of course, taking a look at wages, now if you look at the Employment Compensation index, which is probably the broadest measure, it’s stepped down quite a bit, actually, from about 6% in the first half of the year to about 4.3% in the third quarter.
And that is a similar kind of movement that we’ve seen in average hourly earnings. There I think it’s stepped down from about 4.7 in the first half of the year to about 3.9 in the three months leading up to October. So you know, that does suggest cooling, on aggregate, and lessening wage pressures, and I think it’s important to remember that wages have actually not kept up with inflation. Real incomes have actually, on aggregate, fallen, even though wages are higher than what would be consistent with the run rate associated with 2% inflation. So they’re really in the middle there and they are coming down.
Dual Mandate
Collins: Craig Torres from Bloomberg.
Craig Torres: Vice Chair, when inflation starts to fall, and if unemployment starts to rise, what kind of patience — inflation is a lagging indicator. How much patience will you show to get inflation back to 2, if it’s trending around 3, if the labor market is in distress?
Brainard: We have a 2% inflation target and that is what our monetary policy is designed to achieve along with also a maximum employment objective. So you know, as we go forward, obviously, risks are going to be more two sided as we get into more restrictive or further into restrictive territory. So we’ll be balancing those considerations.
But you know, we are very much focused on achieving our 2% inflation goal. It’s very important to keep inflation expectations anchored around that goal. And so we’ll just have to make judgments like that. As we go forward, what is the appropriate level of restraint on a sustained basis that’s going to be necessary to make that balance?
Global Hikes
Collins: Rachel, as promised, to you.
Rachel Siegel: Thank you. Hi, Vice Chair Brainard, Rachel Siegel from the Washington Post. To follow up on what you were saying about lag effects, can you walk us through what that timeline looks like over the coming year and if you talk about cumulative tightening, how much of that is just from the federal funds rate versus tightening from other central banks around the world too?
Brainard: Yeah, so different people are going to think about those things differently. When I think about cumulative tightening, I really think about financial conditions, because it’s financial conditions that transmit that to decision making by firms who might be borrowing or by households.
The cleanest read, perhaps, is on the Treasury yield curve. And if you just look at that, essentially, we’ve seen the entire curve from one to 10 years move above 1% in real terms. So that’s a big shift in a nine-month period. And that’s one way of thinking about cumulative tightening. And of course, that does take into account not only our actions here at home, but potential spillovers of financial conditions abroad.
In terms of thinking about lags: So there are a variety of different estimates that the research uses different methodologies. So some research methodologies leave you with, you know, many quarters of lags and some suggest that that transmission is somewhat shorter. And so you might be thinking, you know, maybe two to three quarters rather than the longer estimates of lags that come from the historical literature. But even with that, that suggests that it takes some time for that cumulative tightening to really be visible.
So if you think about the housing sector, for instance, you know, that’s where we can see it right away, right? Residential investment has come down extremely rapidly in response to much higher interest rates. But if you think about some of the other decisions that households are making that are perhaps less interest-rate sensitive, it may take quite a bit more time.
And so it’s really going to be, again, an exercise of watching the data carefully, and trying to assess how much restraint there is and how much additional restraint is going to be necessary and to sustain for how long and those are the kinds of judgments that lie ahead for us.
Dissenting Voices
Collins: I think we probably have time for one or two more questions. This side of the room — Howard?
Howard Schneider: Howard Schneider with Reuters. Thanks for being here and taking the questions. With one exception, the Fed has turned on this record-setting shift in monetary policy with only one dissent. And I’m wondering, do you think that’s a strength of the system, that there hasn’t been more sort of public discussion about this, that the language is so fully aligned behind the statements of the of the chair? And how hard has that been to achieve?
Brainard: Well, I do think that there is very strong agreement among committee members on the need to show resolve, the need to keep inflation expectations anchored at 2% and to stop high inflation from getting entrenched. And so I think that is reflected in this really strong support for the rapid, cumulative tightening that has taken place so far, again, almost 4 percentage points of tightening and a period of about nine months at the same time that the balance sheet is being reduced.
But we do have — and I think this is really important — we do have very full discussions among committee members, taking into account all the complicated judgment calls that we’ve been talking about here. How much restraint for how long? How, what data do we look at, given that a lot of data is looking in the rearview mirror? So, I think there’s healthy discussions and I do believe that it’s going to be very important to have those different perspectives, informing our policy deliberations.
Policy Lags
Collins: Time for just one last. Ed?
Edward Harrison, Bloomberg: There’s anecdotal evidence that price-level changes in rentals are coming down. But that’s not necessarily reflected in the data that we see in CPI, for example. How do you look at that in terms of thinking about, going forward, in terms of the lag of the effect of monetary tightening?
Brainard: So housing services is really important. It’s particularly important in CPI, but it’s also important in PCE inflation, and it’s really important in terms of how much money an average household spends each month on housing services. So it really is a big expenditure, usually the single biggest expenditure item for many households, and it’s very salient.
In terms of the data — so the cumulative tightening that’s taken place has really shown up in very large increases in mortgage rates in a very short period of time. You can see that reflected in house prices. House prices across the country had been rising very rapidly. Most indicators now suggest that at best, they’re flattening out and in some cases actually falling. And of course, in some parts of the country, house prices are now falling.
How does that translate into rental pricing? If you look at new rents on new leases — that’s where I think you’re referring to — we’re actually seeing those indices coming down. But for continuing leases, they may actually still be catching up to the market. And so what do we see in the inflation metrics? It’s really the aggregate of different housing services.
So we’re tracking those subcomponents very closely because they’ll give us a sense of when that component is likely to peak. And again, I would say, you know, well into next year, taking into account those offsetting forces, housing services in the inflation series isn’t likely to peak until well into next year. So that’s one of those persistent categories where continued restraint is going to be important to bring inflation down to 2% over time.
Collins: Vice Chair Brainard, thank you so much for the generosity of your time for being here, for answering our questions today.
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